India Sees Growth Imperiled With Greek-Like Tax Evasion

A woman walks near the Ministry of Finance in New Delhi, India. In a country where the per capita income is 50,000 rupees and the income tax exemption limit is 180,000 rupees, only 3 percent of India’s 1.2 billion population pays tax, according to the finance ministry. Photographer: Keith Bedford/Bloomberg

July 19 (Bloomberg) -- As Rama Murthy completes the sale of
his three-bedroom apartment in the southern Indian city of
Hyderabad, he accepts from the buyer a bag full of rupees -- a
part of the purchase price the tax man will never see.

“Almost 40 percent of the sale price I got in hard cash,”
said Murthy, 39, who works at a software maker. “It’s illegal,
but it’s rampant in India to avoid paying tax.”

India loses 14 trillion rupees ($314 billion) from tax
evasion annually, depriving it of funds for investment in roads,
ports and power, said Arun Kumar, author of “The Black Economy
in India.” General government tax revenue totals an estimated
18 percent of gross domestic product, the lowest among the four
BRIC nations, and down from an average 19 percent the past five
years, International Monetary Fund data show.

With so little revenue, the government must borrow more to
fund a planned $1 trillion five-year infrastructure program
needed to help secure Prime Minister Manmohan Singh’s target of
10 percent sustained economic growth. Singh is pushing to pass
legislation by April 2012 that would pare exemptions and lower
personal and company levies to improve compliance, in what would
be the biggest income-tax overhaul in half a century.

“In the last 35 years we have been losing 5 percentage
points of growth every year,” said Kumar, who teaches economics
at Jawaharlal Nehru University in New Delhi. “Instead of 7.5
percent now we could have grown at 12.5 percent. What China and
Southeast Asia achieved, we could have done.”

“If the government does end up making a substantial amount
in revenue as a result of the tax overhaul, their deficit
requirements should come down and the interest burden will also
come down,” said Killol Pandya, Mumbai-based head of fixed
income investments at Daiwa Asset Management (India) Pvt. The
prospect “enthuses me as a bond investor,” he said.

‘License Raj’

India’s post-independence tax and regulatory code created
incentives to keep transactions outside the tax system. Singh
began attacking that structure as finance minister in 1991,
accelerating tax cuts and reducing the bureaucracy. The top
individual income tax rate is now 30 percent, from 97.5 percent
in 1971. The country’s debt still exceeds that of other BRIC
nations, which group India with China, Russia and Brazil, as a
share of the economy, IMF data show.

“For every little thing, companies needed license from the
government,” said D. H. Pai Panandiker, president of RPG
Foundation, a New Delhi-based research group. The so-called
“license raj” encouraged the creation of the underground
economy, he said.

Even today, “no permission is available without the
payment of money, so the cost of doing business is very high,”
said Sharad Kumar Saraf, the managing director of Mumbai-based
Technocraft Industries, which makes steel pipes and fittings for
export.

India’s government revenue as a share of GDP compares with
36 percent in Brazil, 37 percent in Russia and 21 percent in
China, the IMF says. Its debt ratio is 68 percent, against
China’s 17 percent, Russia’s 8.5 percent and Brazil’s 66
percent.

Greek Example

In a country where the per capita income is 50,000 rupees
and the income tax exemption limit is 180,000 rupees, only 3
percent of India’s 1.2 billion population pays tax, according to
the finance ministry. Endemic tax evasion makes it tougher to
stem any crisis in investor confidence, as Greece discovered
last year. The IMF made addressing tax compliance a key part of
its loan program for the European nation.

Singh’s government, which has been rocked over the past
year by its own corruption challenges, including a scandal over
the award of telecommunication licenses, in March appointed
three research institutes to estimate the size of the so-called
black-market economy. They are scheduled to release their
findings and policy recommendations by August 2012.

Singh a year ago introduced the so-called Direct Tax Code
legislation to overhaul levies on companies and households. It
would cut the corporate rate to 30 percent from the current 33
percent and phase out tax “holiday” periods that give
businesses incentives to alter the timing of their transactions.

Incentive to Cheat

“When you give these kinds of tax incentives there is
always the possibility for misuse in the form of money
laundering and shifting of profits,” said Sunil Gupta, a
finance ministry official who helped write the legislation. He
said he hoped it would be enacted by the start of the 2012-2013
tax year next April. Gupta estimated India loses as much as 800
billion rupees a year because of corporate tax incentives.

The bill aims to bring more individuals into the net by
minimizing exemptions, such as for some real-estate transactions
and investments in infrastructure bonds and equity mutual funds.
It would boost by 200,000 rupees a year the sum an individual
has taxed at the lower 20 percent rate.

“Every certified accountant, lawyer and doctor and small
services provider isn’t interested in being part of the
system,” said Kavita Rao, an economist in New Delhi at the
National Institute of Public Finance and Policy who will lead
one of the three black-market economy studies. “It penalizes
the guys who pay taxes.”

Single Tax

A separate effort to overhaul indirect taxes may prove more
challenging as it requires an amendment to the constitution.
Singh plans legislation to introduce a nationwide goods and
services tax, or GST, that would replace most indirect taxes.

The bill may also abolish a state-by-state entry tax that
truckers must pay when they transport items across the country,
said Vivek Johri, an Indian Revenue Service official at the
finance ministry who is helping write the proposed legislation.

Should all the different indirect taxes be replaced by a
single levy, it will be easier to conduct audits of companies,
Johri said. “Right now there are too many government tax
agencies who are not talking to each other. That will change.”

A third effort is to rewrite a tax treaty with Mauritius,
an Indian Ocean island chain and suspected destination of a
share of flows of unreported income out of India. Finance
Minister Pranab Mukherjee said June 21 the two have resumed
talks on the matter. Under the current arrangement, capital
gains on Indian shares held by a Mauritian company aren’t
subject to Indian tax.

Hamstrung in Parliament

One challenge underlying all of the initiatives is a
political paralysis in parliament that’s hamstrung Singh since
corruption charges erupted over irregularities in the 2008 sale
of licenses to run mobile-phone services. One minister was
forced to resign over the scandal and is in jail along with a
federal lawmaker and company executives as their trial
continues.

“The government must start the reform process once
again,” Adi Godrej, chairman of Godrej Consumer Products Ltd.,
said in an interview with Bloomberg UTV on July 8. “Because of
the corruption scandals the government went into hibernation.
The most important legislation that could really kickstart the
economy quickly to 10 percent growth is the introduction of the
GST.” India’s GDP expanded 7.8 percent in the first quarter
from a year before.

Election Funds

Another reason for lawmakers’ reluctance to embrace the
government’s legislation is that a portion of India’s unreported
cash is plowed into election campaigns, analysts said.

“The mother of all corruption in India is election
corruption,” said N. Bhaskara Rao, chairman of New Delhi-based
Center for Media Studies. “The biggest outlet for black money
is election spending and political parties will only be
curtailing their spending power by backing proposals to curb
black money.” He estimated that parties spend $22 billion a
year on elections to state and parliamentary seats.

Unreported money sometimes goes back into the economy:
Murthy, who sold his apartment for 2.2 million rupees, said he
used part of his bag of cash to buy a refrigerator and an air
conditioner.